Modelling uncertain operational cash flows of real estate investments using simulations of stochastic processes

Abstract

Purpose – The purpose of this paper is to apply a numerical simulation of stochastic processes to the problem of real estate investment appraisal.Design/methodology/approach – These uncertain operating costs are integrated into an enhanced dynamic simulation. To model the dynamics in the uncertainty of the cost schedule, a range of different types of stochastic processes is used. The operating costs are classified by cost drivers and an appropriate stochastic process is determined for each of the derived cost clusters. To optimise the capital structure in this application, heuristic optimisation with genetic algorithms is used.Findings – The application of the model to real world investment situations shows that linear and deterministic modelling underestimates the risk‐generating effect of uncertain operating expenses, which often can lead to inefficient investment decisions.Practical implications – In a further application of the model, the authors demonstrate the effect of uncertain operating costs on ...